As you know, the first bailout proposal was rejected by Congress by 12 votes. The bill then went to the Senate where they attached $150 Billion in “sweeteners” which they then passed and sent to the House. This time the House also passed the bill (here’s the entire document) with flying colors. So what kind of “entitlements” were added to the bill? Here’s the complete list.

I defy anyone to tell me what the excise tax exemption for “Wooden Arrows Designed for Children” has to do with solving our credit crisis. Not even the writers for David Letterman or Jay Leno could have made this stuff up! The tragedy, of course, is that we have a real problem to solve while our “leaders” in Washington play games with legislation. And our credit “virus” has proven contagious, jumping across the Atlantic where it’s impacting European banks. Since the bill’s passage, the stock market has become less than impressed when investors realized the effects of the introduction of $700B into the market would take longer than they would like. Paulson indicated he needed several weeks to develop a plan for deploying the money. Apparently, spending $700B is a big job…where do I sign up to help?

The Shame

The portion of the bill having to do with the credit problem is essentially unchanged, which tells you Congress was more interested in their entitlement programs than solving the real problem. And here’s the irony, we really didn’t need the bailout bill at all…

Our fractional reserve banking system has worked well for decades. When a large and complex system such as this breaks down, it’s useful to look back to see what, if anything, has changed. In the case of our current banking crisis, what changed most recently was the introduction of a new set of accounting rules regarding mark-to-market asset valuation, formally known as FAS 157, in November of 2007. See my previous post for more depth on FAS 157.

The story of FAS 157 begins with the Enron disaster in an attempt to correct specious asset valuations that hid the problems within a company that truly demonstrated capitalism run amok. Enron was playing fast and loose with the valuation rules in effect at the time, and FAS 157 was the SEC and FASB’s answer. Arming the SEC with a stronger FAS 157 rule was like giving them a hammer, and once they had a hammer everything started to look like a nail…including mortgage-backed securities. The result decoupled the valuation of these thinly-traded securities from their component mortgages and collateral properties. The estimates I’ve seen say banks have had paper losses of $500B in assets due to this uncoupling which translates into $5 Trillion lost in lending capacity! Many of these securities had to be written down to zero in the collapsing market for them following the rules of FAS 157. But wait a minute, the intrinsic value of the mortgage balances and collateral property contained in these securities certainly hasn’t gone to zero!

Contrary to what you’ve probably heard about needing more regulation, ironically, FAS 157 represented the application of too much regulation. If we want to free up our credit system and re-energize the stock market we just need to take the following steps:

1. Rollback the asset valuation rules for mortgage-backed securities, FAS 157, to those that existed before Nov 2007. This will allow these securities to regain their lost value on balance sheets and immediately free banks to begin lending again. No central plan or infrastructure to deploy billions of dollars will be needed, just a rule from the SEC. This step will free up credit “instantly” and won’t cost us a dime.

2. Establish “Mark-to-Reality” valuation rules. In deference to the SEC, the asset valuation rules prior to Nov 2007 were not as accurate as they should have been, in many cases allowing assets to be valued based on their purchase price…which would not be accurate during the life of these securities. But instead of playing “Whack-a-Mole” with FAS 157, all we need are “Mark-to-Reality” rules that would require banks holding mortgage-backed securities to mark each individual mortgage and property to current assessed valuation and do this on a periodic basis, say quarterly. While this would be a lot of work, if you had an asset like a mortgage-backed security worth $100M, don’t you think it would be worth the effort to protect that asset?

3. Changes going forward. We can’t undo the mortgage securities that currently exist. We can, however, establish more conservative guidelines for new mortgages that require “old-fashioned” rules like…having a down payment!

Summary

By analogy, our situation is like you waking up one morning, turning on your PC and discovering it doesn’t start up. You have some important work to do so you call in expensive consultants and they proceed to dismantle your machine looking for the problem. It’s then that you discover the machine wasn’t plugged in…

The SEC didn’t need an act of Congress to get us into this problem; we don’t need one to get out of it. It’s time to realize we can free up the credit markets in relatively short order so we can focus on our energy issue that is costing us $700B every year by eliminating our dependence on foreign oil through a Carbonless Electric Economy. If you agree, you might want to do what I did and write to your representatives in Washington telling them to rollback FAS 157 for mortgage-backed securities, it’s just that simple. Using this website, you can enter your address and obtain the contact information for your representatives, including their email addresses. If you want to reference this article, simply copy this link into your message: http://tinyurl.com/rollback-fas157